Key things every Startups needs to know about ‘Angel Tax’

India is emerging as a hub for startups. As per the Economic Survey for 2018-19, India stands on the third rank for being the most startup friendly country in the world. Indian Government has taken several steps to support the startup vision of every individual in the country. In its last tenure, Prime Minister Narendra Modi had launched his flagship program the ‘ Make in India’ and other schemes like ‘Startup India’. However, the startups in India are under tremendous pressure due to angel tax levied on them.

Start-ups

What is Angel Tax?

The Angel Tax or section 56(2) (viib) introduced in the IT Act is a tax which is placed on the Indian startups on the capital raised by them from Indian investors above the fair market value of the securities issued. The capital raised above the fair value is then treated as income and taxed accordingly.

In order to curb the black money circulation as investments, the UPA government had constituted the angel tax in 2012.  It was announced by the then finance minister Pranab Mukherjee during the Union Budget 2012.

Why it is an issue?

Since last year around 80 startups have received notices to pay the angel tax. Many of the founders have shown their displeasure after they were asked to pay as much as 30 percent of the tax as their funding. Angels have been given notices to submit details of their sources of income, their bank statements, and other financial data.

The angel tax has been highly opposed by the startups in India because the share issued to an investor has to be valued on the basis of whether the price was in excess to that of the fair value.

The industry, however, has demanded that the discounted cash flow (DCF) method of valuation should be used to calculate the angel tax rather than the net asset value (NAV) method. However, this will also not be able to capture the real value of a startup.

The valuation of the startup is normally done on the commercial negotiation between the investor and the company.  However, the estimated growth prospects of the startup and future projections based are on these growth prospects are the major factors of determining the fair market value of the startup.

The methodology difference in the calculation of the market value of the startup makes it pay a hefty price in terms of angel tax at a whopping 30 percent.

What steps the government is taking?

The Finance Ministry giving relief to startups in India has announced that it will simplify the Angel Tax assessment process and no action will be taken against any of the startups which are recognised under DPIIT unless taking approval from the supervisory officer.

As per the official notification by the Finance ministry, “Central Government has further decided to relax Para-6 of the DPIIT notification No 127 (E) dated 19 February 2019 and make it clear that this notification will also be applicable to startup companies where addition under section 56(2)(viib) has been made and the assessee has been recognised by the DPIIT and subsequently filed Form No 2.”

The move comes two days after latest CBDT circular, which stated that the officials will not follow up on the review process for the companies which was registered under the Startup India program during the course of the angel tax review. Whereas the official would require the approval of their direct supervisor or senior authority to inspect unregistered startups.

Startups in India have got a major boost after this notification by the government to ensure that no genuine entrepreneurs are affected by this provision which allows the government to demand tax on share premium, treating it as income.

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